Oil and the Ghost of 1920

The Harry Coulby, built in 1927, worked the Great Lakes until 1995.
Jim Hoffman/The Interlake Steamship Company

By

John Bussey

Updated Sept. 13, 2012 9:21 p.m. ET

The surge of new American shale oil heading down pipelines to the Gulf Coast will do two things:

It will depress oil prices at points along the route, presenting a big opportunity for refineries and consumers to enjoy a windfall of cheaper fuel.

And it will test a protectionist shipping law that may impede these gains. Most people probably have never heard of the Jones Act. It is either essential for national security or a vast barnacle on the hull of U.S. growth, depending on your point of view.

The Jones Act, known formally as the Merchant Marine Act of 1920, requires that any shipment from one U.S. port to another be carried on vessels built in the U.S., owned by U.S. citizens, and operated by a U.S. crew. The restrictions, in part, reflected Washington's post-World War I desire to have a guaranteed merchant marine.

But there's a price for that. The law can drive up the cost of coastal and inland shipping, push traffic onto rail and trucks, and create other dislocations.

"You have to ask what's good for the country," says Tom Allegretti, the CEO of American Waterways Operators, a trade group for ship owners. The Jones Act, he says, boosts the economy by keeping roughly 74,000 maritime jobs in the U.S., helps national security by making a fleet available for the military, and assures homeland security by keeping transportation in the hands of U.S. citizens.

"Opening that trade to foreign vessels and crews going through the internal arteries, going by [a] stadium in Pittsburgh? It would be mindless to repeal the law," he says.

"That's ludicrous," responds Sen. John McCain, a hawk on national security who has tried, and failed, to revoke the law. "Thousands of foreign ships put into our ports and don't present a problem to our national security." He says the law is just "protectionism" for the shipping industry and unions. "These arguments are laughable."

Some 40,000 vessels—tankers, freighters, ferries, tugs, barges—are governed by the Jones Act, many of them committed to specific runs, such as Alaska to California.

Ed Morse, an energy expert at Citigroup, says the Gulf Coast will soon be "super saturated" with oil from fields such as the Bakken in North Dakota and the Eagle Ford in Texas. Refineries in the Northeast want to replace their expensive imports with that oil. But, he says, the tight supply of Jones Act ships and their rates are "a problem."

John Demopoulos of Argus Media, which tracks pricing, estimates that foreign-flagged carriers could move oil from the Gulf Coast to the Northeast for about $1.20 a barrel, compared with $4 a barrel on U.S. ships.

Already the Northeast refineries are turning to more costly rail transport (sufficient West-East pipelines don't exist). Questions about ship availability also prompted Washington to waive the Jones Act last year when it released oil from the Strategic Petroleum Reserve and during operations after Hurricane Katrina. Authorities needed substantial and fast action, and they called in foreign ships.

Similarly, during a decline in refining capacity in the Northeast earlier this year, the U.S. Energy Information Administration said refined products from other locales might not easily reach the market.

"Vessel constraints" were top of mind, as were "Jones Act vessel rates, which seem to run two to three times foreign-flag ship rates," the agency said. "But since Jones Act vessels are not readily available, actual transportation costs might have to be considerably higher than current rates to bid scarce vessels away from their current business."

Jim Henry, president of the Transportation Institute, which represents ship owners, says "supply and demand will rule here." If the market needs more ships, "we'll construct new vessels to meet the demand. You can build ships in American shipyards very competitively."

ENLARGE

But demand is already here. Rail lines are seeing a jump in requests to move oil to the East. As for the competitive pricing of America's protected shipyards, just ask Bob Kunkel. A marine engineer, he sought to start a business moving cargo on the East Coast on special container ships. He needed four new vessels.

Mr. Kunkel said the ships cost about $35 million to $50 million to build in Europe. But under the Jones Act, he'd need to buy American. The U.S. price: more than $100 million per ship. He shelved his business plans.

And there are other disjunctures: GEGE-0.08% wanted to ship a big wind turbine to Kenya from the U.S., part of a potentially larger export deal. Its export financing from the U.S. required using an American ship. But GE says few Jones Act ships could handle the large load, and the cost was so high—20% of the cost of the turbine—that the company shipped the machine from its German plant instead.

Similarly, Hancock Lumber near Portland, Maine, has for years been trying to ship its product from Maine to Puerto Rico. The company says it can't find a U.S. ship to handle the business.

"We're still incurring the high cost of trucking the lumber from our saw mills to Florida and barging it from there," Hancock's Kevin Hynes says.

As for the oil that's gathering in the Gulf Coast, this bulletin: Recently, the newly commissioned tanker American Phoenix, built by BAE Systems in Mobile, Ala., sailed to Bayway, N.J., from Corpus Christi, Texas. It offloaded a valued cargo: Eagle Ford shale oil.

There was buzz in maritime circles about the load.

That's because the Phoenix and its rare delivery are—for the moment at least—an exception that proves the rule.

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